Investors who purchased hundreds of billions of dollars of mortgage bonds issued before the financial crisis will soon find out whether they can proceed with claims that sponsors of these deals misrepresented the quality of the underwriting.

New York’s highest court is expected to rule imminently on whether to reverse a lower court’s decision that would invalidate claims brought against residential mortgage-backed securities (RMBS) sponsors by investors in 2006 and 2007 vintage deals, during the peak of the housing bubble.

At the state court level, Judge Shirley Kornreich interpreted the statute of limitations on a claim in favor of investors in May 2013, allowing the claim of a breach of representations and warranties to proceed.  In December, that decision was reversed, upholding defendant DB Structured Products’ argument that the six-year statute of limitations began on or before the deal’s 2006 closing date. The plaintiff, trustee HSBC, argued instead that the statute of limitations began later, when the RMBS sponsor was alerted of the breach and given time to “cure” it.

Should the New York State Court of Appeal uphold the reversal, the impact will have broad implications.  

“If it’s six years from the contract’s closing date, then the 2006 and 2007 vintage deals will have no more remedies under New York State law. We take exception to that,” said Chris Katopis, executive director of the Association of Mortgage Investors (AMI).  

In late May the AMI filed a brief in support of the plaintiff, noting that “the structure and terms of the RMBS transaction at issue in this case are, broadly speaking, similar to those of most RMBS transactions. The resolution of this appeal could therefore have far-reaching consequences for RMBS investors, including AMI’s members.”

The RMBS market has been a shadow of its former self since the housing bubble deflated, partly due to concern about the success of litigation related to the transactions’ reps and warranties, which if breached should give investors the power to push back loans to sponsors.

“Our guys are very leery about going back into these deals, and that’s why the RMBS market has practically ground to a halt,” Katopis said.

HSBC was trustee on the ACE deal, and it has since taken over the plaintiff role from the trust created by ACE, hiring Paul Clement as counsel of record. That it brought onboard a former solicitor general and one of a select group of lawyers that regularly argues before the Supreme Court and the state appellate courts illustrates the stakes involved in the case. The plaintiff noted in a January brief that a decision in favor of the defendant would eliminate hundreds of cases already brought by RMBS trustees that were filed more than six years after they acquired the underlying loans for the securitization, reflecting hundreds of billions of dollars in losses.

Isaac Gradman, an attorney at Perry Law who has closely monitored RMBS litigation stemming from the housing bubble, said that if the appeals court decides in favor of the plaintiff, “Then put-back claims filed more than six years after the creation of the trust will be back on the table.”

He said that, so far, those claims have been very successful, largely surviving motions to dismiss, and “If the monoline settlements are any indication, the actual merits of the breach claims are very strong and will carry the day.”

The AMI brief argues that the terms of the RMBS agreements, as well as public statements of many loan sellers, make clear that loan sellers agreed to resolve issues with problematic loans on an ongoing basis as they arose, and that their responsibility to repurchase the loans was based on first having the opportunity to “cure” them. And it’s at that point that the statute of limitations begins for claiming breach of contract of the reps and warrants.

“Now, however, these banks seek to avoid their obligations and shift all risk and liability for the intentional securitization of bad loans by asserting the statute of limitations in a manner contrary to intentions of the parties and the decisions of this Court,” AMI’s brief states.  

HSBC filed its leave to appeal, enabling the appeal of the reversal to proceed, in late April. DB Structured Products filed its opposition two weeks later. Gradman said this timeline suggests that the highest court’s decision to proceed or not may arrive in July. If HSBC’s appeal moves forward, there will be several months of briefs and oral arguments, potentially resulting in a final decision in first quarter 2015.

If the appellate court decides not to proceed, and the door is shut against sponsors, then investors may turn their sights on trustees, which like HSBC, as trustee on the ACE deal, often delayed representing investors in any actions against the banks.

“The case law says these are really the trustees’ claims to bring. So parties that tried to go through the trustee, and may have made repurchase demands through trustee, and the trustee failed to act …. We’re investigating very seriously whether the trustee has liability,” Gradman said.

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